While in recent years the unemployment rate has fallen from its peak of over 11 per
cent in the early 1990s, the current rate of unemployment – at just over
8 per cent, about the average for the past fifteen years – is still of
concern for both economic and social reasons. From an economic perspective,
unemployment represents the underutilisation of one of the economy's main
resources, labour. Socially, unemployment is associated with an array of problems,
not least a lower standard of living and lower self-esteem for the unemployed.

The higher rate of unemployment since the mid 1970s is not a problem unique to Australia.
A large number of OECD countries have experienced a similar rise. There have,
however, been some exceptions. Most notably, the unemployment rate in the United
States has fluctuated around a relatively constant level for over three decades.
Whereas in the 1960s and early 1970s the structure of the labour market in
the United States was sometimes criticised for delivering higher unemployment
rates than other OECD countries, today it is often held up as the example to
which other countries should aspire. On the other hand, the relatively low
unemployment rate in the United States has been associated, in the past two
decades, with widening wage inequality.

The contrast between continental Europe and the United States is often seen as illustrating
a trade-off between a lower unemployment rate and a more unequal earnings distribution.
An important consideration in such a trade-off is the interaction of the labour
market with the social security system. A wider distribution of labour income
could be mitigated by an appropriately targeted tax and welfare system that
sought to avoid high effective marginal rates of taxation that might act to
discourage individuals from seeking or accepting employment opportunities.

The papers in this volume were commissioned by the Bank and the Centre for Economic
Policy Research at the Australian National University to consider the issue
of unemployment in Australia and to contribute to the debate about policies
to reduce unemployment. The papers covered three main issues:

The labour market experiences of other OECD countries have been diverse over the
past three decades, as evidenced by the range of unemployment outcomes. These
varied experiences can provide lessons for Australia about the impact on unemployment
of different labour market institutions and the effectiveness of different
policies. Cross-country comparisons can also shed light on the existence of
the ‘diabolical trade-off’ between higher unemployment and greater
wage inequality, and on measures that can be undertaken to circumvent such
a trade-off.

The microeconomic aspects of the Australian labour market are important in determining
the appropriate policies to reduce unemployment. However, little is known
at the microeconomic level about the way in which employment and wages adjust
in response to developments both within and outside the labour market. Nevertheless,
it is clear that the incidence of unemployment has been unevenly distributed
across different sections of the Australian population.

There is an array of possible solutions to unemployment. A common theme that runs
through all the papers presented at the conference is that there is no easy
policy prescription to reduce unemployment. Rather, any approach must encompass
a range of different measures, and further, important synergies may emerge
when a coherent strategy is adopted that simultaneously implements these measures.

International perspectives

Many commentators have highlighted the distinction between labour market developments
in continental OECD Europe and the United States. The stylised description
is that the United States has enjoyed a lower unemployment rate than continental
Europe because of greater flexibility in its labour market, but that this has
come at the cost of a wider dispersion of incomes.

The paper by Jackman reveals that such a stylised description conceals a variety
of differences within continental Europe. The dispersion of unemployment rates
between European countries is greater than that between Europe and the United
States. Some of the countries with relatively heavily regulated labour markets,
such as Austria, have had low unemployment rates for a number of years.

Furthermore, a simple static comparison between Europe and the United States may
be misleading. An important feature of labour market institutions is their
ability to cope with unexpected shocks. In the 1960s, the different structures
of labour market institutions across countries may have been less important
in the relatively benign economic climate. However, the more tumultuous economic
environment of the 1970s may have exposed the previously hidden deficiencies
in labour market structures in a number of countries.

It is difficult to isolate those features of the US and the various European labour
markets that have led to such divergent outcomes. Moreover, it is dangerous
to draw strong conclusions about the efficacy of a particular labour market
policy without considering the interactions of that policy with the other labour
market institutions in the country concerned. Thus, the adoption in Australia
of a policy that has been effective in another country may not generate the
same beneficial outcomes given the different institutional structure.

This lesson is further borne out in the comparison between the labour market experiences
of Australia, New Zealand
and the United Kingdom described in the paper by Wooden and Sloan. Significant differences
in the speed and process of labour market reforms in the three countries have
not, to date, generated dramatically different labour market outcomes. However,
the labour market outcomes are also likely to have been affected by other factors,
such as differences in the macroeconomic environment and the nature of the
reform process in other areas of the economy, in particular the product market.

The United States is often held up as the benchmark for assessing the effectiveness
of labour market institutions in other developed countries. The paper by Katz
describes the multiple dimensions of the US labour market experience. From
the standpoint of overall employment outcomes, the US labour market is outstanding.
The employment to population ratio in the United States has risen steadily
over the past twenty-five years, indicative of the fact that the US labour
market has absorbed the concurrent large increase in labour supply, particularly
of females. The US labour market has provided good outcomes for females and
young workers compared with a number of European countries where labour market
interventions have served to primarily protect the employment of prime-aged
males at the expense of other groups in the workforce. On the other hand, the
employment to population ratio of prime-aged males has declined in the US.

The degree of, and trends in, income inequality in the United States appear less
favourable in international comparisons. The US has historically had a relatively
wide wage distribution and over the past two decades, wage inequality has been
growing and real wages at the bottom end of the distribution have fallen. This
outcome has been partially attributed to the impact of skill-biased technological
change; that is, developments in technology over a number of years have tended
to favour high-skilled or more-educated workers.

It is often argued that the interaction of skill-biased technological change with
the more flexible wage-setting system in the US has resulted in increased wage
dispersion, whereas in many European countries, skill-biased technological
change has been reflected in rising unemployment rates of less-skilled workers.
However, the empirical evidence suggests that such a characterisation is simplistic.
Firstly, unemployment rates are higher in Europe than in the US across all
skill categories. Secondly, much of the rise in inequality is ‘within
group’ inequality; that is, wages have become more dispersed for workers
with very similar characteristics including education and measurable skills.
The lack of a satisfactory explanation for these trends in inequality in the
US complicates the task of drawing lessons for Australia.

Unemployment in Australia

Since 1960, the ratio of the number of people employed to the working-age population
in Australia has fluctuated around a relatively constant level, while the unemployment
rate has risen from around 2 per cent in the 1960s to an average of around
8½ per cent over the past fifteen years, with most of the rise occurring
in the second half of the 1970s. By definition, this implies that the growth
in the demand for labour has not kept pace with the growth in the supply of
labour, which is indicative of shortcomings in the operation of the Australian
labour market.

The trends in the unemployment rate over the past thirty years highlight the key
influence of economic growth and trends in labour costs on labour market outcomes.
Increases in the unemployment rate occurred primarily in three relatively short
episodes associated with the sharp contractions in economic activity in the
mid 1970s, 1982–83 and 1990–91. Furthermore, the rises in the unemployment
rate in these episodes tended to be considerably faster than the falls in the
subsequent recoveries, highlighting the costs of variability in growth. The
sharp rise in labour costs in 1974 and 1982 exacerbated the cyclical rises
in unemployment experienced at those times (and indeed contributed to the contractions
in economic activity themselves). Falling unemployment throughout the second
half of the 1980s owed a lot to restraint in aggregate wage growth, as well
as the sustained period of expansion in economic activity.

The effects of adverse movements in labour costs may also be quite persistent. While
restraint in the growth of wages has seen real unit labour costs return to
the levels of the 1960s, the unemployment rate still remains considerably higher.
This is consistent with the idea that changes in labour costs can have long-lasting
effects through their influence on investment decisions which, in turn, determine
the stock of physical capital and therefore the productive potential of the
economy.

Examining developments in the labour market from an aggregate perspective can conceal
important developments at a more disaggregated level. The paper by Borland
and Kennedy documents variations in the incidence of unemployment across different
groups in the population. While the unemployment rate has risen for all sections
of the population, the rise has not been uniform. The labour market experiences
of males and females have differed significantly: the male employment to population
ratio has declined by more than 15 percentage points over the past thirty years,
whereas that of females has increased by a similar amount. This largely reflects
the divergent performance of industries which predominantly employ males, such
as manufacturing, compared with those which employ more females, such as service
industries. It also reflects the large increase in part-time employment. Over
the medium term, one might expect to see the divergent labour market trends
of the two genders diminish as males increasingly seek part-time work and employment
in industries that have historically employed more females.

The other notable divergence in labour market outcomes is that between skilled and
unskilled workers. Unemployment rates are considerably higher for less-educated
and less-skilled workers. Again, this is not particular to Australia, but is
evident in most OECD countries, and may reflect the impact of skill-biased
technological change. As discussed above, skill-biased technological change
need not lead to higher unemployment rates for less-skilled or less-educated
workers if the relative wage paid to those workers declines. In Australia,
the tendency has been for quantity adjustment rather than price adjustment,
as evidenced by the relatively higher unemployment rates of the less skilled.
However, there has also been a quality adjustment in the Australian labour
force. The increase in high-school retention rates and the increased participation
in tertiary education both suggest that people are responding to the divergence
in the unemployment rates induced by the skill-biased technological change,
by seeking to improve their skill and education levels. If this is so, then
in the medium term, the increased supply of skilled labour should reduce the
difference in unemployment rates and decrease wage dispersion.

The substantial rise in the unemployment rate and the wide range of unemployment
rates across different groups in the population both suggest that much of the
adjustment in the labour market occurs, at least in the shorter term, through
adjustment in quantities – that is, the number of people employed –
rather than price – that is, the wage. The institutional structure of
the labour market has a large influence on the extent to which prices or quantities
adjust.

The institutional structure of the labour market and the social security system also
have a large influence on income distribution. The unemployed receive relatively
low incomes because their primary source of income is unemployment benefits.
Thus, the unemployed are at the lower end of the individual income distribution.
In principle, however, many unemployed people could live in households where
there are other sources of income which might offset their low personal income.
Harding and Richardson present evidence in their paper that suggests this is
generally not the case. Many unemployed people live in a household where there
is no other breadwinner. Consequently, households with an unemployed member
are disproportionately concentrated at the lower end of the household income
distribution. In contrast, households with individuals who are employed on
relatively low wages are more evenly spread across the household income distribution.

The evidence also shows that government cash benefits are the primary source of income
for families with an unemployed member, but are only a very small source of
income for families with wage and salary earners, implying that the welfare
system in Australia is relatively well targeted. However, it also means that
any possible solution to unemployment must consider the interaction of changes
in the wage structure with the welfare system.

Finally, to understand the rise in unemployment it is important to understand how
the labour market adjusts to adverse developments. It is necessary to know
how firms adjust their hiring and investment decisions in response to changes
in the macroeconomic environment and to changes in the costs of employing labour
or capital. The paper by Freebairn documents that, unfortunately, there is
comparatively little evidence on the microeconomic workings of the Australian
labour market. Such information is vital when considering the design of policies
to address unemployment.

Solutions

When contemplating possible solutions to unemployment, the experiences of Australia
and other OECD countries indicate no obvious or easily implementable path.
Rather, an effective solution needs to draw on a number of different elements.
Furthermore, consideration of the interaction of the different components of
the policy package is important, rather than analysing and adopting each policy
in isolation. For example, labour market programs are likely to be more effective
in an environment of sustained growth.

A critical element in any approach is the maintenance of a non-inflationary rate
of economic growth that is as steady as possible. The paper by Dungey and Pitchford
highlights that output growth is a major determinant of employment growth,
and that recessions can have large and long-lasting detrimental effects on
the unemployment rate. Consequently, macroeconomic policy can contribute to
improved labour market outcomes by aiming to achieve the highest possible rate
of economic growth while maintaining a low inflation environment.

There are, however, limits to the extent to which growth alone can permanently reduce
the unemployment rate. Unemployment in Australia currently has a sizeable structural
component. Attempts to further reduce unemployment below this rate through
macroeconomic stimulus are likely to be inflationary. Specific policies are
needed to reduce this structural component.

The paper by Debelle and Vickery suggests that moderate, but sustained, wage restraint
can deliver sizeable reductions in the structural unemployment rate. The difficulty
is determining the means by which to achieve aggregate wage restraint. In abstract
terms, too high a level of aggregate wages reflects an imbalance of labour
market power between active participants in the labour market (insiders), and
those with a less effective presence (outsiders). Such an imbalance can diminish
the benefits of productivity-enhancing reforms if the increase in productivity
is captured predominantly by those already employed, in the form of higher
wages, rather than being more evenly distributed across the whole population,
in the form of increased employment.

One means of increasing the bargaining power of outsiders is to use active labour
market programs. Drawing on the large variety of programs that have been adopted
in OECD countries, the paper by Martin presents a checklist of those labour
market programs that appear to work and those that do not. The general aim
of such programs is to increase the ability of the unemployed to compete effectively
in the labour market by increasing ‘job readiness’ in terms of
basic work skills and by assisting the unemployed in locating employment opportunities
through the provision of information, or the provision of wage subsidies which
increase their attractiveness to potential employers. Labour market programs
which target potentially disadvantaged groups at an early age, while initially
expensive, can avoid greater costs in the future.

A particularly effective type of labour market program is one that provides opportunities
for the workforce to increase their education and skill levels. However, care
must be taken to avoid the pitfall of encouraging individuals to remain in
certain forms of education which, while temporarily reducing the measured unemployment
rate, do not provide them with the necessary training to increase their future
employability. Education, like all other forms of labour market programs, needs
to be carefully targeted. Furthermore, labour market institutions should be
structured to allow the unemployed with increased skills and education to compete
effectively with the insiders.

A necessary element in any solution to unemployment is entrepreneurship. Without
a sufficient pool of entrepreneurial skills, there will not be adequate employment
opportunities for the workforce to utilise their skills and education. Impediments
to risk-taking need to be minimised so that businesses can create jobs in response
to enhanced labour market flexibility and the availability of skills.

Some decrease in unemployment could be achieved through increased relative wage flexibility,
rather than through increased aggregate wage flexibility. That is, the wide
range of unemployment rates across the different groups in the workforce may
reflect the inability of the wage-setting system to allow relative wages to
adjust to imbalances in labour demand and supply. Allowing greater adjustment
in relative wages may also deliver a lower aggregate wage level, as relative
wages fall for those groups experiencing the higher unemployment rates.

An outcome where wages fall for certain sections of the population may raise concerns
about equity. However, the inequity of lower wages must be weighed against
the inequity of unemployment, particularly given that unemployed households
are, in general, lower in the income distribution than low-wage households.
An important issue in such a debate is whether the employment generated by
the lower wage outcomes is the first point in a career path that leads to higher
wages later in the working life, or whether those gaining employment predominantly
remain locked into low-wage employment. The evidence on this in Australia is,
however, fairly scant.

A policy prescription to reduce unemployment that includes a reduction in real wages
should also consider the interaction of the wage system with the social welfare
and tax systems. The social welfare system is an effective channel for providing
assistance to low-income households, but it is essential to ensure that it
does not create incentives for benefit recipients to avoid participation in
the workforce. Thus, a necessary component of any reform package should be
the reduction of high effective marginal tax rates facing lower income workers,
without compromising the social objectives of the welfare system.

In summary, there are many dimensions to unemployment and correspondingly many elements
in any solution to unemployment. A policy approach that is likely to lead to
a sustained fall in unemployment will require the maintenance of steady non-inflationary
growth, and will include measures that increase the employability of those
without jobs, such as education and re-skilling, and increase their relative
bargaining power, to restrain growth in labour costs.